Six Reasons Every Construction Owner Should Exercise Caution When Considering a "Mutual" Waiver of Consequential Damage Provisions

Six Reasons Every Construction Owner Should Exercise Caution When Considering a "Mutual" Waiver of Consequential Damage Provisions - August 2007

The vast majority of design and construction agreements utilized in the United States are based on form agreements published by professional societies and contractor trade groups such as the American Institute of Architects (AIA), Associated General Contractors of America (AGC), Engineers Joint Contract Documents Committee (EJCDC), and the Design-Build Institute of America (DBIA). While these documents are sophisticated in scope, they are frequently unbalanced as with respect to the interests of the Owners or Developers who are asked to sign them. An excellent example of this bias is the "mutual" waiver of consequential damage provisions commonly found in these form agreements.

In most states, parties to a contract are liable for all losses that arise by a breach of the agreement that are reasonably within their contemplation when they enter into the agreement. This rule applies to both direct and so called "consequential" losses resulting from a breach of contract. The "mutual" waivers seek to limit sharply the parties' right to recover such damages; in effect the waivers are limitations of liability, which transfer risk back from designers and builders to their owner clients. Although these waivers are found in "standard" industry contracts, owners should use caution in agreeing to them.

Following are six key reasons why owners should think carefully about "mutual" waivers before signing design or construction agreements.

The risk and potential severity of damages waived by the parties are not "mutual" and the clause favors Designers and Contractors. On virtually all projects, an owner's "consequential" losses significantly outweigh the designer's or contractor's. An owner's potential "consequential" losses might include profits, income or revenue, loss of use, increased financing costs, loss of reputation, etc. The potential losses will typically exceed, for example, the contractor's (which will consist of such losses as extended overhead or general conditions, delays and profits). The waiver simply does not impact the parties to a similar degree, and the notion that it is truly mutual in effect is misplaced.

The term "consequential damages" is ambiguous, without clear definition. The term "consequential damages" has been notoriously difficult for courts to define with precision. Indeed, some suggest there is no meaningful distinction. Looking to "direct damages" does not help, because that concept has been equally elusive to define.

The Waiver allocates risk to the party least able to manage or mitigate the risk. It seems universally accepted that effective risk management provides that risk be allocated to the party best able to minimize or avoid it. However, the mutual waiver does just the opposite. A contractor, for example, likely will have control over the means and methods of the construction and is thus far better positioned than the owner to avoid the consequential damages. Owners, in contrast, will have very little means or methods control, as they surrender the site and execution to the contractor.

The Waiver prevents the fair compensation to the Owner. Breach of contract damages are intended to restore the aggrieved party to the position it would have had if the contract had been fulfilled according to its terms. However, the waiver may very clearly leave the owner without recourse for all or a major portion of the harm it suffers.

The Waiver limits an Owner's right to recover damages which would defeat the purpose, at least in part, of Designer's or Contractor's obligation to purchase insurance. Some aspects of an Owner's consequential damages may be covered by a designer's or contractor's insurance. Since the cost of procuring this insurance is presumably built into the contract price, the Owner is in essence paying to insure itself against damages that it must waive, at least in part.

The “mutual waivers” provisions can be internally inconsistent with other provisions of the form agreements. For example, within the AIA’s popular A201, General Conditions document, several provisions seem to contradict the waiver (found at 4.3.10) and allow the contractor or owner to recover “consequential damages.” Potentially contradictory language exists at Sections 2.4.1, 3.2.3, 6.2.3 and 14.4.3. Deletion of the waiver cures this flaw.

For more information about the use of "mutual" waivers of consequential damage provisions, please contact Christopher S. Dunn at 800-487-6380.

The opinions expressed in this bulletin are intended for general guidance only. They are not intended as recommendations for specific situations. As always, readers should consult a qualified attorney for specific legal guidance.